The Netflix disaster after the close could trip up the entire market.

The S&P gains since January have been produced by only five stocks. Five big cap Nasdaq stocks have supplied 91% of the gains on the S&P. This is extremely narrow market breadth and very dangerous. Since January 1st, Amazon was responsible for 35% of the S&P gains, Netflix 21%, Microsoft 15%, Apple 12% and Facebook 8%.

A healthy market advances by a strong ratio of advancers to decliners. The S&P has 500 stocks and a positive market should see 65% or more on average that are rising every day. In 2018, that ratio on average has been around 50%. That means 50% of stocks are rising and 50% are declining on average. This means there is a lack of conviction by both buyers and sellers. There are exceptions where a headline sends the indexes into a tailspin and decliners are in the 75% to 80% range. In theory, market technicians want to see that 65% or better ratio of advancers over decliners in order to feel comfortable with a market rally.

The problem with the majority of gains coming from only five stocks is that we are dependent on continued gains in those stocks for the market to move higher. If something should happen to those five market leaders, the market is likely to decline due to lack of market breadth.

Today Netflix reported earnings that disappointed the street and the stock declined $57 dollars in afterhours trading. That is a 14.25% decline in just a couple hours and there is a strong chance the decline could continue. Before today, Netflix was up 108% for the year from $192 to $400 with recent analyst price targets as high as $500.

When a star performer like Netflix posts a significant disappointment, it changes investor sentiment for the stock. Everyone that was wildly bullish before is forced to rethink their position. Investors that had held all year just saw 25% of their gains disappear in just a couple hours. There will be some who will buy the initial dip but there will be others making the decision to take their remaining profit and run.

With Netflix one of the big five gainers for the year, the earnings disaster could force investors to reconsider their positions in those other four stocks. If these leaders suddenly become laggards, even if it was only a minor weakness, it could impact sentiment all across the tech sector.

Investors should always look for positive market breadth as a leading sentiment indicator along with better than average volume. Analysts claim volume is a weapon of the bulls and weak volume along with narrow breadth signifies a weak market even if it is posting gains.

Volume has been relatively weak and breadth has been terrible. Everyone continues to pin their hopes on the 21-24% earnings expectations for Q2. That is a strong tailwind for stocks but there are still some roadblocks in our future.

Now that the Russian summit and the NATO meeting are behind us, President Trump will come home and more than likely return to tweeting about the Chinese trade issues. Investors have glazed over to some extent after weeks of increasing rhetoric but that does not mean they cannot be shocked out of their earnings trance by some sudden tweet.

We are facing significant risk in August and September from tariff issues and those are already the two worst months of the year for the market. We should gratefully accept any further gains in July then prepare for some exits in early August.

The S&P could not hold over 2,800 but only posted a -2.88 loss. That is just noise at this level. Friday was a six-month high. The index is still in breakout mode but it could face some challenges on Tuesday if those five tech leaders become laggards.


The Dow was helped significantly by a big gain in Boeing and the two banks. Goldman has earnings on Tuesday and JPM was on Friday. Goldman was up on news they were replacing Lloyd Blankfein as CEO. Boeing was up sharply after announcing $4.7 billion in new orders at the Farnborough International Air Show. There will be further orders announced. DHL placed an order for 14 777 freighters and options for seven more.

The Dow will not have those same boosts on Tuesday and support at 25,000 is likely to be tested.



The Nasdaq posted a minor loss of 20 points but it will start out in the negative on Tuesday. The Nasdaq futures are trading about 50 points below their 4:PM close. If Netflix poisons sentiment for the FANG stocks, we could see a sharp decline at the open.



The Russell continues to be hurt by rotation back into the big caps. This will end immediately once the China headlines come back into focus.


The earnings pick up the pace this week with three Dow components reporting on Tuesday. Those are GS, JNJ and UNH. This week is a tease. Next week is a flood.


The calendar is headlined by the back-to-back testimony by Fed Chairman Jerome Powell. He will be the main attraction if there are no tweet storms.


I would expect a dip at the open. The S&P futures are up about 2.50 tonight but the closer we get to morning the more likely to decline. I would let the initial dip run its course and look to buy the dip for a short-term trade around 10-10:30 but only IF it appears to have run its course. Watch the FANG stocks for direction. If they turn positive, the coast is clear.

Enter passively, exit aggressively!

Jim Brown

Send Jim an email



NEW DIRECTIONAL PUT PLAY

AMBA - Ambarella - Company Profile

Ambarella, Inc. develops semiconductor processing solutions for video that enable high-definition (HD), video capture, analysis, sharing, and display worldwide. The company's system-on-a-chip designs integrated HD video processing, image processing, computer vision functionality, audio processing, and system functions onto a single chip for delivering video and image quality, differentiated functionality, and low power consumption. Its solutions enable the creation of video content for wearable cameras, automotive cameras, and professional and consumer Internet Protocol (IP) security cameras, as well as cameras incorporated into unmanned aerial vehicles in the camera market; and manage IP video traffic, broadcast encoding and transcoding, and IP video delivery applications in the infrastructure market. The company sells its solutions to original design manufacturers and original equipment manufacturers through its direct sales force and distributors. Ambarella, Inc. was founded in 2004 and is headquartered in Santa Clara, California. Company description from FinViz.com

Ambarella used to be the sweetheart of the semiconductor industry with their camera chips capturing a wide swath of the up and coming devices. Unfortunately, you cannot rest on past accomplishments.

Shares have declined almost 40% since January. The drop began when one of their customers reported weak sales and falling demand for that company's products. When they reported Q1 earnings they beat the street but lowered guidance and that caused another move lower.

Then GoPro said they would no longer sell the Karma drone, which had 12 cameras with Ambarella chips. Since GoPro accounted for roughly 20% of Ambarella's income that was a major blow. With their Q1 earnings Ambarella said GoPro income would be non-existent for the rest of the year. They said revenues would be "insignificant" in 2018 compared to $37 million in 2017. Analysts are cutting forecasts and trashing talking Ambarella's outlook.

The company is also facing new competition from Qualcomm and that will increase if they eventually acquire NXP Semiconductor as expected.

Earnings September 4th.

Ambarella shares closed at a two-year low on Monday and very close to a major breakdown. I am recommending we play that breakdown.

Buy Nov $35 put, currently $2.70, stop loss $41.25. We will exit in September or earlier.



Current Portfolio


Open Positions

Check the graphic below for any new stop losses in bright yellow. We need to always be prepared for an unexpected decline. Any items shaded in blue were previously closed.




Current Position Changes


SKYY - Cloud ETF
The long call position was entered at the open on Tuesday.


Original Play Recommendations (Alpha by Symbol)


ANIK - Anika Therapeutics - Company Profile

Comments:

No specific news. Shares flattened at $35. Earnings are July 25th. Expectations should be low. We are going to hold over.

Original Trade Description: July 2nd.

Anika Therapeutics, Inc., together with its subsidiaries, provides orthopedic medicines for patients with degenerative orthopedic diseases and traumatic conditions in the United States and internationally. The company develops, manufactures, and commercializes therapeutic products based on its proprietary hyaluronic acid (HA) technology. Its orthobiologics products comprise ORTHOVISC, ORTHOVISC mini, MONOVISC, and CINGAL for the treatment of osteoarthritis of the knee; HYALOFAST, a biodegradable support for human bone marrow mesenchymal stem cells used for cartilage regeneration and as an adjunct for microfracture surgery; HYALONECT, a resorbable knitted fabric mesh; HYALOSS used to mix blood/bone grafts to form a paste for bone regeneration; and HYALOGLIDE, an ACP gel used in tenolysis treatment. The company's dermal products include wound care products that comprise HYALOMATRIX and HYALOFILL for the treatment of complex wounds, such as burns and ulcers, and for use in connection with the regeneration of skin; and ELEVESS, an aesthetic dermatology product. Its surgical products comprise HYALOBARRIER, a post-operative adhesion barrier for use in the abdomino-pelvic area; INCERT, a HA product used for the prevention of post-surgical spinal adhesions; MEROGEL, a woven fleece nasal packing; and MEROGEL INJECTABLE, a viscous hydrogel. The company also offers ophthalmic products, including injectable HA products that are used as viscoelastic agents in ophthalmic surgical procedures, such as cataract extraction and intraocular lens implantation; and veterinary products, which include HYVISC, an injectable HA product for the treatment of joint dysfunction in horses. Anika Therapeutics, Inc. has a strategic collaboration with the Institute for Applied Life Sciences at the University of Massachusetts Amherst to develop a therapy for rheumatoid arthritis. Company description from FinViz.com

Anika has had several problems recently. They disappointed on earnings in early May and shares fell $11 the next morning. The stock rebounded and recovered all the loss then in mid June they reported weak results from a trial on Cingal, for osteoarthritis in the knee. The drug performed as advertised but did not generate a statistically significant reduction in pain. The trial has been extended. The drug is already approved overseas for this condition. Shares fell $18 on the news.

Anika announced an accelerated share buyback program for $30 million, 6% of the outstanding shares, to be completed in June. Shares are rebounding again. After two bouts of very sharp declines, this could be a major buying opportunity. Worst case we could see shares ease a little higher on the buyback program.

Earnings August 1st.

Position 7/3/18:
Long Aug $35 Call @ $1.45, see portfolio graphic for stop loss.



CHGG - Chegg Ing - Company Profile

Comments:

No specific news. Shares holding just under new highs.

Original Trade Description: May 29th

Chegg, Inc. operates direct-to-student learning platform that supports students on their journey from high school to college and into their career with tools designed to help them pass their test, pass their class, and save money on required materials. The company offers Chegg Services, which include digital products and services; and required materials that comprise its print textbooks and eTextbooks. Its digital products and services include Chegg Study, which helps students master challenging concepts on their own; Chegg Writing that enables automatically generate sources in the required formats, when students need to cite their sources in written work; Chegg Tutors that allow students find human help on its learning platform through a network of live tutors; Chegg Math, an adaptive math technology and developer of the math application; Brand Partnership, which offers various ways for student-relevant brands to reach and engage high school and college students; Test Prep that provides students with an online adaptive test preparation services; and internships services. The company rents and sells print textbooks and eTextbooks; and offers supplemental materials and textbook buyback services. The company has a strategic alliance with Ingram Content Group. Company description from FinViz.com

CHGG reported earnings of 10 cents on revenue of $77 million to beat estimates of 9 cents and $74 million for the fifth consecutive earnings beat. Cash on the balance sheet reached a record high of $500 million compared to $66 million in Q2 2017. Jefferies said the cash pile offered Chegg the opportunity to expand its business outside of its own organic growth.

Shares have been rising steadily since the earnings beat in February and closed at a new high on Tuesday in a very bad market.

Update 7/9: Chegg acquired StudyBlue for $20.8 million in an all cash transaction. There will be no change to 2018 earnings but they will take a $1 charge in 2019 for facility consolidation. The acquisition will add a significant number of subjects to their existing offerings. The new offerings will include online flash cards. In 2016 29% of students used online flashcards. That roies to 37% in 2017 and continues to rise. Fifty percent of students claimed that was their only method of study.

Earnings August 2nd.

Position 5/30/18:
Long Oct $30 call @ $1.95, see portfolio graphic for stop loss.



IWM - Russell 2000 ETF - Company Profile

Comments:

We have seen four minor declines in the last five days as money rotates out of the small caps and back into the big cap international stocks. Rumors of a potential trade deal continue to circulate despite Treasury Secretary Mnuchin saying negotiations have failed. The instant headlines begin to appear, the rotation should stop and even reverse.

Original Trade Description: June 25th.

The S&P futures have recovered from -4.50 earlier in the session to +3. The Dow dipped to the 200-day and then rebounded to close just below that critical average. It could be close enough to attract some risk takers.

The S&P dipped to the strong support of the 100-day at 2,702 and rebounded to close just above the 50-day at 2,716. These averages should be decent support as long as there are no additional tariff surprises. In President Trump's speech tonight, he was careful to push hard on the topic that the tariff war would be resolved peacefully. While we may not end up with no tariffs between countries, he teased that tariffs would be reduced significantly. That appeared to ease the market tensions overnight.

I wanted to play the SPY instead of the IWM because it has fallen farther and could rebound the most. However, as long as there are tariff threats the place to be is the Russell and the drop in the IWM gave us an entry point.

Position 6/26/18:
Long Sept $168 call @ $3.66, see portfolio graphic for stop loss.
Optional: Short Sept $155 put @ $2.38, see portfolio graphic for stop loss.
Net debit $1.28.



MRCY - Mercury Systems - Company Profile

Comments:

No specific news. Shares continue to rebound and closed at a 3-month high.

Original Trade Description: June 4th

Mercury Systems, Inc. provides sensor and safety critical mission processing subsystems for various critical defense and intelligence programs in the United States. The company's products and solutions are deployed in approximately 300 programs with 25 defense prime contractors. Its principal programs include Aegis, Patriot, Surface Electronic Warfare Improvement Program, Gorgon Stare, Predator, F-35, Reaper, F-16 SABR, E2D Hawkeye, and Paveway. The company also designs, markets, and licenses software and middleware environments under the MultiCore Plus name to accelerate development and execution of signal and image processing applications on a range of heterogeneous and multi-computing platforms. In addition, it offers hardware products, including components, such as power amplifiers and limiters, switches, oscillators, filters, equalizers, digital and analog converters, chips, monolithic microwave integrated circuits, and memory and storage devices; embedded processing modules and boards, switch fabric boards, high speed input/output boards, digital receiver boards, multi-chip modules, integrated radio frequency and microwave multi-function assemblies, tuners, and transceivers, as well as graphics and video processing, and Ethernet and input-output boards; and integrated subsystems. The company was formerly known as Mercury Computer Systems, Inc. and changed its name to Mercury Systems, Inc. in November 2012. Company description from FinViz.com

In April Mercury reported earnings of 30 cents that missed estimates for 35 cents. Revenue of $116.3 million missed estimates for $123.3 million. Mercury said government budget issues shifted $11 million in revenue into the next quarter.

The company guided for revenue of $146.7-$151.7 million in the current quarter and significantly above Q1 levels. They raised full year guidance to $1.35-$1.38 per share on revenue of $464-$468 million.

Shares were crushed for a $16 drop or -35% on the news. They have been rebounding steadily since early May.

Bookings rose 41% to a record $150 million. They now have a record backlog of $429 million in orders. They are guiding for a 20% rise in revenue in 2018 with 23% EBITDA margins.

Earnings July 24th.

I understand the reasons for the Q1 miss. Government budget deadlines are highly unreliable. Also, they just completed the acquisition of Themis Computer, which added additional onetime costs. With the raised guidance, the drop should eventually be erased. This is a tech stock in the defense sector. How much better growth and security could you get?

Position 6/5/18:
Long October $40 call @ $2.60, see portfolio graphic for stop loss.



SKYY - Cloud Computing ETF - ETF Profile

Comments:

No specific news. New closing high on Thursday.

Original Trade Description: July 9th.

The First Trust Cloud Computing ETF is an exchange-traded fund. The investment objective of the Fund is to seek investment results that correspond generally to the price and yield, before the Fund's fees and expenses, of an equity index called the ISE Cloud Computing Index. The index is a modified equal dollar weighted index designed to track the performance of companies actively involved in the cloud computing industry. To be included in the index, a security must be engaged in a business activity supporting or utilizing the cloud computing space, listed on an index-eligible global stock exchange and have a market capitalization of at least $100 million.

All securities are then classified according to the following three business segments: Pure Play Cloud Computing Companies: Companies that are direct service providers for "the cloud" (network hardware/software, storage, cloud computing services) or companies that deliver goods and services that utilize cloud computing technology. Non Pure Play Cloud Computing Companies: Companies that focus outside the cloud computing space but provide goods and services in support of the cloud computing space. Technology Conglomerate Cloud Computing Companies: Large broad-based companies that indirectly utilize or support the use of cloud computing technology.

The ETF was started in 2011 and now has $1.4 billion in assets. The ETF really took off in 2016 and has been rising steadily. There have been some hiccups recently as some major companies disappointed on earnings and when the Nasdaq corrected in February and March. The ETF has caught fire in the recent tech rebound and with the Nasdaq about to break out to a new high it should continue to do well.

With Q2 earnings over the next six weeks, picking a tech stock gives us a limited time for appreciation and there is always the risk of a disappointment in a stock in the same sector. By using the ETF we can benefit from the tech rally without having too much exposure to a single stock. The idea is to profit from appreciation while reducing volatility.

Shares appear poised to break out to a new high.

Position 7/10/18:
Long October $57 call at $1.25, see portfolio graphic for stop loss.


VXX - Volatility Index Futures - ETF Description

Comments:

The VXX continues to decline and closed at a new five month low.

Original Trade Description: September 18th.

The VXX is a short-term volatility ETF based on the VIX futures. As a futures product it has the rollover curse. Every time they roll to a new futures contract, they have to pay a premium and that lowers the price of the ETF. It is a flawed product with a perpetual decline built in from the monthly roll over in the futures contracts.

As evidence of this flaw, they have now done five 1:4 reverse stock splits. The last five reverse splits occurred at $13.11 (11/2010), $8.77 (10/2012), $12.84 (11/2013), $9.52 (8/8/16), $12.77 (8/22/17). The prospectus says it can reverse split anytime it trades under $25 for a prolonged period and the splits will always be 1:4.

We know from experience that the VXX always declines.

Unfortunately, put options are expensive with a volatility instrument at this price level. The only recommendation is to short the ETF and forget it. If we do get a new rally into the Q1 earnings cycle we could see a sharp decline in the VXX over the next 2-3 months. This will be a long-term position. This is not a 2-3 week play. I can guarantee you, if history holds, we can play this until it splits 1:4 again at $10. Once we are in the position and profitable I will put a trailing stop loss on it. We will take profits and then look for a bounce to get back in.

The VXX is hard to short. There are 34.2 million shares outstanding and ShortSqueeze.com says 44.5 million are short. The shares are out there and being traded because the volume on Monday was 46.5 million. More than 221 million traded on Feb 5th. This ETF is a favorite vehicle for the computer traders so the volume is always high. You have to tell your broker you really want to short it and make them find the shares. Sometimes it takes days or even a week before your broker will find you the shares. Trust me, be persistent and it will be worth the effort.

Previously: On Feb-5th a reader emailed me saying a friend was short 1,000 shares. When the VXX spiked $21 in afterhours, Ameritrade closed that position for a $35,000 loss. They did not have a protective stop loss.

We are not using a profit stop in this position because it could be hard to re-short the shares after a volatility event. That is just trade management for a profitable position.

In ANY SHORT POSITION, you should have a catastrophe stop loss to avoid the position turning into a major loss. Had this person had a stop loss at their entry point, they would have been closed for a breakeven and they would be sleeping a lot better today.

Readers should always assume the potential for the worst possible outcome of a short position. Trade smart!

Position 2/13/18:
Short VXX shares @ $49.16, no initial stop loss.



Prices Quoted in Newsletter

At Option Investor, we have a long-standing policy prohibiting the editors and staff from actually trading the individual recommendations in order to conform to SEC rules concerning trades.

The prices quoted in the newsletter are the end of day prices in most cases.

When discussing fills or stops the prices quoted are the bid/ask at the time the entry trigger or exit stop is hit. This is NOT a price that someone on staff actually got using a live order.

For entry/exit points at the market open the prices quoted will be the opening print. The majority of the time readers are able to get a better fill than the opening print because of market maker bias at the open.

For trades with an opening qualification the prices quoted will be the bid/ask at the time the qualification was met.

All of these rules normally produce worse prices than an active trader would normally get. Because they are standardized there may be some cases where a price quoted was better than an actual fill. If you received a price that was dramatically different than what was quoted please let us know.